Ahead of an expected surge in U.S.-listed ETFs, the Canadian ETF Association (CETFA) is proposing policy reforms aimed at levelling the playing field between Canadian and U.S. ETF providers as stiff competition for investor dollars persists.
The association is lobbying the federal government to consider the introduction of a so-called Maple Investment TFSA that would incent Canadians to invest domestically, the removal of sales tax on ETF management fees and a review of the Canada Revenue Agency’s (CRA) allocation-to-redeemers (ATR) tax formula.
It’s also calling for greater coordination between the various securities regulators in the country to achieve more consistency in terms of fees and regulations, and for these bodies to impose the same rules on Canada-listed ETFs as they do on foreign-listed ETFs.
Eli Yufest, executive director of CETFA, said these reforms are necessary to ensure the long-term survival of Canada’s ETF ecosystem — especially as the U.S. is expected to see a flood of new ETF share classes launch now that a patent on the dual class product structure in that country, which was long held by Vanguard Group, has expired. Canada, meanwhile, has offered ETF share classes since 2013.
“There’s a tsunami on the horizon,” he said in an interview.
“We need to make changes now to make sure that we’re setting ourselves up for success in the future.”
Asked if the federal government is considering any or all of the proposals, a spokesperson for the Department of Finance said, in a written statement, “it would be inappropriate for the [department] to speculate on any potential or prospective changes.”
Meanwhile, the Canadian Securities Administrators (CSA) said its members will meet with CETFA “to discuss its concerns.”
“Many of CETFA’s proposals are related to tax policy, and as regulators, we seek to support and provide our expertise where appropriate,” the CSA said in a written statement.
“Securities regulators need to balance investor protection issues, regulatory burden, and maintaining fair and efficient markets when it comes to the availability of U.S. ETFs through Canadian brokerage accounts.”
According to Yufest, more than 30% of every dollar invested by Canadians in ETFs goes to U.S.-listed products, and with more than 90 asset managers in the U.S. looking to launch an ETF share class of their existing mutual fund portfolios, CETFA is concerned that more Canadian investor dollars will soon flow into U.S.-listed funds.
“Now that Canadians will have access to some of the most successful funds in the world, they’re going to increasingly be incented through all the tax and structural issues that we have here in Canada to continue to put more money into these ETF share classes,” he said.
“And so, just back-of-napkin math, if there are 90 American issuers that have applied for an ETF share class, and they each launch 20 ETFs, … that’s over 1,800 new ETFs that are [estimated] to hit the market that Canadians are now going to have access to [through Canadian brokerage accounts].”
The proposals
To help Canadian-listed funds stay competitive with their U.S.-listed counterparts, the industry association has proposed the creation of a Maple Investment TFSA.
As Yufest explained, the proposed savings account — which would purposefully include “investment” in its title to encourage people to not let their cash sit idly in it — would give Canadians a higher capital allowance than in a regular TFSA if they choose to purchase Canadian-listed funds. It would also encourage them to invest in domestic funds because, if they were to do so, the government would match their contributions up to a certain point, much like an RESP account.
“We’re not asking for a prohibition, we’re not asking for blocking foreign ETFs, but what we’re asking for is to incent Canadians to keep more of their money here in Canada,” Yufest said.
CETFA’s also pushing for the removal of GST/HST from ETF management fees to make Canadian-listed funds more attractive, given that sales tax isn’t applied to the management fees of U.S.-listed funds.
“Even if Canadian issuers are trying to be as competitive as possible versus their American counterparts, with the same sort of underlying [securities] in the same sort of fund, we’re always going to … be structurally more expensive — 13% more expensive — in terms of management fees,” Yufest said.
The Securities and Investment Management Association, which last August put forward its own proposal for the government to scrap sales tax on all fund management fees, didn’t comment directly on CETFA’s policy proposals. However, it said in a written statement that it “supports policy measures that improve outcomes for investors, strengthen Canada’s capital markets and keep the domestic asset management industry competitive.”
Dan Hallett, vice-president, research and principal with Oakville, Ont.-based HighView Financial Group, said the CRA’s recently revised stance on mutual fund trailing commissions — which means they will generally be subject to GST/HST starting in July — doesn’t bode well for CETFA’s proposal.
“I don’t see how they’re going to make that case,” Hallett said in an interview.
Asked about this recent development, Yufest said his association is waiting to get clarity on how this might impact its proposal to have sales tax scrapped on ETF management fees.
“We’re waiting to speak to the government about the implications of that,” he said.
Hallett added that he understands why CETFA wants to incent Canadians to purchase Canadian-domiciled ETFs but pointed out that U.S. ETFs have been accessible through Canadian brokerage accounts “for a long time” and there are already some “hurdles that will turn some people off” from investing in them.
For example, he noted that while U.S.-domiciled funds may be offered with lower management fees, two factors that tend to turn Canadian investors off from U.S. ETFs include the need to navigate complex U.S. estate tax rules and currency conversion fees. The currency conversion factor, in particular, has directly contributed to the influx of Canadian Depository Receipts, which allow investors to diversify their investments while mitigating the currency risk that is associated with cross-border investing.
As such, Hallett said he doesn’t believe the introduction of U.S. ETF share classes is “a major threat to the Canadian ETF” and that it’ll just cause the number of investment product choices available to investors to balloon.
Tiffany Zhang, director, ETFs and financial products research with National Bank Capital Markets, similarly said in an email that the launch of the first U.S. ETF share classes beyond Vanguard will result in more product options for U.S. and Canadian investors alike. Currently, there are already more than 4,800 ETFs listed in the U.S.
However, she noted that while many U.S. ETFs benefit from their large-scale operations and tax efficiency that allow them to be low in cost and highly liquid, Canada has built “a deep, innovative ETF ecosystem” with more than 1,800 ETFs with varying strategies across multiple asset classes, which is “closely tailored to Canadian investor needs and Canadian market structure.”
And although her team has no insight into the progress of CETFA’s lobbying efforts “to remove or reduce structural and tax frictions” or the potential regulatory outcome of the association’s proposals, she said “it’s fair to say that in today’s competitive ETF landscape where fees and bid/ask spreads have come down, basis points matter.”
“Policies that help reduce the holding and trading costs of ETFs have an impact on investor decisions and generally lead to better investment outcomes, all else being equal,” Zhang added.
Further, CETFA is proposing a review of the current ATR formula. In essence, the formula affects how allocations of capital gains are treated when investors make redemptions from mutual fund trusts (including those that are ETFs).
A change to the formula, which became law in 2022 and applies to taxation years that begin after Dec. 15, 2021, is meant to limit the amount of capital gains that mutual fund trusts (including those that are ETFs) can allocate to redeeming unitholders. However, if the redemption-related gains of an ETF exceed the formulaic limit, any excess gains are now typically borne by investors who choose to stay in the fund, even though they didn’t choose to redeem their units.
As well, the impact of the revised formula is not equal across all ETFs, as the formula takes into account an ETF’s net asset values (NAVs) as of the end of the current and preceding tax years, the amount that was redeemed by unitholders and the capital gain for the entire year. As previously reported, there could be distortions since the formula only measures the NAVs at specific points in time, and market conditions could work favourably or unfavourably in the interests of investors of a specific fund.
In the absence of similar tax treatment of U.S.-listed ETFs, the industry association is worried that more Canadian capital will be diverted south of the border.
“The federal government, the regulators, need to move with urgency on some of these things,” Yufest said.